It is often said that hard money is aimed at people with poor credit. Such thinking is often the result of misunderstandings about the hard money industry. It is also incorrect thinking. Hard money lenders are not looking to lend to people unlikely to repay. It’s just that credit scores have very little bearing on how they do business.
Credit Scores and Traditional Lending
A borrower’s credit score matters a great deal when it comes to traditional lending. Think about your own circumstances. When you bought your house or financed your new car, you had to provide documentation proving your income. Meanwhile, the lender looked at your credit report.
All the combined data is utilized by lenders to determine two things:
- Your ability to repay; and
- The likelihood that you will default.
If your ability to repay is questioned and your likelihood of default is high, you probably won’t be approved. And even if you are, you’re going to be offered the worst rates and terms around. Lenders do that to protect themselves.
Hard Money Is Entirely Different
A borrower looking to obtain a hard money loan is looking at an entirely different scenario. Hard money lenders, like Actium Lending out of Salt Lake City, UT, are less interested in credit scores and history. A borrower’s credit score may influence rates and terms, but it has little to do with approval.
A hard money lender doesn’t need to assess a borrower’s ability to repay. The likelihood of default is also less of a concern. Why? Because hard money lending is asset-based. This means that borrowers put up assets as collateral. Approval decisions are made on the value of those assets rather than on paystubs, credit scores and histories, and so forth.
At this point, it is worth noting that the vast majority of hard money borrowers are real estate investors. The target properties they are hoping to acquire act as collateral for their hard money loans. Under certain circumstances, a borrower might throw in a second piece of property to increase collateral value.
Banks Utilize Collateral, Too
You could make the case that banks require collateral, too. After all, your bank put a lien on your home when you closed. The lien establishes a financial interest in the property for as long as you have an outstanding loan balance. Once your mortgage is paid in full, the lien is removed.
The thing that makes collateral different in the residential mortgage market is the lender’s recourse in the event of default. Mortgage lenders are required to go through a lengthy and complicated process just to repossess a distressed property. Then it’s even more trouble to sell that property and get enough to recover the outstanding balance.
Without getting into all the details, a hard money loan is not a mortgage. It is usually structured as a trust deed transaction. Such transactions give hard money lenders a lot more leeway should legal action be necessary. A hard money lender will not have to wait for a court case to wind its way through the system.
Better Than a Credit Score
Hard money lenders see collateral as better than a credit score. Collateral gives lenders access to immediate remedies in the event of default.
If you have always assumed that hard money is for people with poor credit, you now know the truth. An individual’s credit has very little to do with it. Hard money lending is asset-based, credit scores don’t mean as much. What matters is the value of the collateral being put up by the borrower.